Key Points:
- The fiscal theory of the price level (FTPL) explains inflation as a result of excessive government debt that cannot be repaid through future taxes or spending reductions.
- Inflation occurs when people anticipate that government debt will not be repaid, leading them to spend the debt rather than hold onto it.
- The current inflation episode can be explained by the FTPL, as the US government printed trillions of dollars and borrowed additional funds to send checks to people.
- In the period between 2008 and the COVID-19 pandemic, low inflation despite fiscal and monetary stimulus can also be explained by the FTPL, as there were depressed demand and low interest costs on government debt.
- The FTPL is a combination of fiscal and monetary policies, and historical episodes of inflation have been driven by fiscal problems.
- Fiscal reforms and solving the fiscal problem are necessary to end inflation.
“The current inflation episode is just the kind of event that the fiscal theory of the price level can easily describe. It’s simple. The US government printed up about $3 trillion of money and sent people checks. It borrowed an additional $2 trillion of money and sent people more checks.” — John H. Cochrane, Senior Fellow, Hoover Institution, Stanford University
“The fiscal theory, I think, is the right way to approach monetary issues and inflation. I don’t think it’s well accepted. It’s not what central bankers or a lot of academic economists adhere to . . . It’s also a heretical view. It happens to be the right one. But it’s still an uphill battle.” — Thomas S. Coleman, Senior Lecturer, Harris School of Public Policy, University of Chicago
John H. Cochrane and Thomas S. Coleman have made significant contributions to the understanding of the fiscal theory of the price level (FTPL). The FTPL explains inflation as a result of excessive government debt that cannot be repaid through future taxes or spending reductions. Inflation occurs when people anticipate that the government debt will not be repaid, leading them to spend the debt rather than hold onto it.
The current inflation episode, characterized by soaring inflation rates, can be easily explained by the FTPL. The US government printed trillions of dollars and borrowed additional funds to send checks to people, resulting in a significant increase in government debt. While borrowing by itself is not instantly inflationary, sending people checks is a powerful way to encourage spending of the new debt. This fiscal intervention, coupled with the increase in the amount of government debt, has contributed to the current inflationary environment.
In the period between 2008 and the COVID-19 pandemic, there was a puzzle of low inflation despite massive fiscal and monetary stimulus. The FTPL offers an explanation for this phenomenon. Firstly, there was depressed demand, which limited the impact of increased aggregate demand on inflation. Secondly, the fiscal stimulus during that period was relatively small compared to the recent stimulus, resulting in a smaller impact on inflation. Additionally, low interest costs on government debt played a role in keeping inflation at bay.
Historically, the FTPL highlights the importance of fiscal problems in driving inflation. Countries with steady primary surpluses and robust economic growth tend to have low inflation, regardless of the actions of central bankers. Inflation often arises from fiscal stress, as seen in episodes like the US inflation of the 1970s and 1980s, where fiscal factors combined with monetary policies shaped the inflationary environment. The FTPL emphasizes the need for both fiscal and monetary policies to solve the fiscal problem and end inflation.
